Download Price StabiUty, Market Controi and Imports in the Steel Industry

Price StabiUty, Market Controi
and Imports in the Steel Industry
ROBERT R. MILLER
Some observers have a+tribufed price stability in
the steel industry to the vertically integrated structure
of the steel industry. This article suggests that the industry's pricing strategy is
based not only on the industry structure, but also on its
somewhat unique market
characteristics.
Imports
have been limited to relatively few market segments,
and there appears to be
little likelihood that other
market areas will be materially affected by imports in
the foreseeable future.
Journal of Marketing. Vol. 32 (April.
1968). pp. lG-20.
MERICAN steel producers in the last decade have been faced
with increasing amounts of low-priced imports of basic steel
products. This intensified international competition stems from the
capacity expansion and return to world trade of Japan and Western
European nations following World War II reconstruction. Prior
to 1958, steel imports at no time supplied more than 2% or 3%
of total domestic consumption. Today, in contrast, imported steel
products account for over 11% of the total quantity used, and in
some items now supply the predominant amount sold in the open
market. In some coastal areas, U. S. steel firms have nearly been
displaced in supplying such common products as nails and reinforcing bars.
If this competition had come from a domestic firm, or group
of firms, steel industry leaders undoubtedly would have reacted
by lowering prices for the affected products to match or even
maintained or even raised above domestic prices existing before
undercut the competitive level. In the present import situation,
however, such price cuts have not been forthcoming, except in a
few special cases. Instead, steel product prices generally have been
substantial imports were a factor.
A
Industry Structure and Steel Pricing
One reason for the resistance of the steel industry to meeting
lower import prices has been suggested by Walter Adams and
Joel Dirlam.^ In their view, the refusal to lower prices was based
on the industry's history of price leadership and its vertically
integrated structure. According to the Adams-Dirlam argument,
the decision to maintain price levels maximized industry profits,
assuming: (a) effective price leadership, (b) production by the
fully integrated firms at each fabrication stage, (c) the belief by
price makers that inelastic industry demand existed for all products, and (d) dependence for materials by intermediate fabricators on the integrated firms. Under these conditions, lowering a
price for an intermediate product, such as wire rod or wire, would
cause deterioration of prices at successive levels. Resulting profitability losses, assuming small amounts of imports, would exceed the loss incurred by refusing to meet the lower price level.
Similarly, maintenance of pre-import prices for final products, such
as nails and barbed wire, was intended to reduce the possibility
Walter Adams and Joel Dirlam, "Steel Imports and Vertical Oligopoly
Power," American Economic Review, Vol. 54 (September, 1964), pp.
626-655.
16
Price Stability, Market Control, ami Imports in the Steel Industry
of severe and widespread price cutting, which again
would lower industry profits.
Exceptions to the price maintenance decision occurred only when small domestic competitors, producing relatively few items, were forced by imports
to lower prices or when other materials, such as
aluminum, were introduced as substitutes for steel.
In these cases, downward price adjustments were
made reluctantly by the major integrated firms. In
other cases, industry leaders vociferously maintained
their desire to protect smaller "independent" producers from margin-reducing price cuts and on several occasions have surrendered large segments of
individual product markets rather than meeting- a
lower import price.
Other possible reasons for the industry's reluctance to cut prices have been suggested.-' However,
all explanations so far put forth, including the
Adams-Dirlam argument, depend on one assumption:
for the price maintenance policy to be successful,
steel industry executives must have had a strong
a priori notion that market losses to imports would
be relatively limited. Clearly, if foreign shipments
were anticipated ultimately to absorb a large proportion of the total market at all levels in the
vertical structure, a policy which ignored this
eventuality would have been untenable. The observed decisions of industry price setters, therefore,
implied the belief that the long-run price elasticity
of demand for steel imports was low, even with
relatively higher domestic mill prices. In other
words, the steel industry's pricing actions were
premised on the assumption that non-price factors
would encourage American steel users to retain
domestic sources of supply regardless of price differentials often substantially favoring foreign suppliers. Certainly the extent of market gain by
importers which took place in a limited number of
products could not have been thought likely in all
product lines.
Importance of Market Structure
The purpose of this article is to demonstrate that
this expectation was not unwarranted. By considering the market and distribution structure of the
steel industry, it can be shown that many steelusing industries have been essentially closed to substantial import competition. Moreover, barring the
possibility of a widening of price differentials between domestic and imported steel in the future,
which appears unlikely, the percentage of foreignproduced steel to total domestic consumption should
stabilize at approximately the current level. In the
long-run, of course, the changing structure of comparative advantage in the world could result in
2 See especially, G. A. Hone and D. S. Schoenbrod,
"Steel Imports and Vertical Oligopoly Power: Comment," American Economic Review, Vol. 56 (March,
1966), pp. 156-159.
17
wider price differences. In the foreseeable future,
however, the continuing installation of modern plants
in the United States should at least preserve the
nation's present competitive position.
Price discrimination, or "dumping," by foreign
producers also could lead to lower import prices.
For the purposes of this article, extensive dumping
is assumed to be effectively prevented by existing
anti-dumping legislation.^
Steel products in this country are primarily distributed in two ways: (1) customers can mill-order;
that is, place orders with the steel producer and
receive shipments directly without any market intermediary; (2) for smaller quantities, usually
less-than-carload lots, orders are directed to a wholesaler or jobber. Of the two means of distribution,
mill-ordering is by far the more important, accounting for about four-fifths of the total quantity of
steel products shipped. Both methods of distribution, however, reach a wide variety of customers
exhibiting a range of purchasing characteristics.
These buying characteristics have in large measure
determined the susceptibility of various market
segments to import competition.
Large Steel-using Industries
Automobile manufacturers provide an example
of one type of direct purchaser. These companies
in a typical year purchase approximately one-fifth
of the total amount of steel produced. Sales normally are made on the basis of negotiated prices;
list prices serve only as a starting point in negotiation. The automotive firms estimate annual requirements for various steel products and enter into
purchase contracts to cover these needs. The steel
producer generally agrees to deliver steel in relatively small lots throughout the year to conform
closely with the customer's anticipated production
For recent relative price movements in steel products,
see Irving B. Kravis, Robert E. Lipsey, and Philip
J. Bourque, Measuring hiier)iational Price Competitiveness: A Preliminary Report, Occasional Paper 94,
National Bureau of Economic Research, New York,
1965.
• ABOUT THE AUTHOR. Professor Miller teaches courses in International business and managerial economics at the
University of Iowa. During the period
[954-1961. he was employed by the
General Electric Company in various
marketing positions. More recently, he
has been affiliated with the Stanford
Research Institute as an economic consultant.
Prior to going to Iowa, he
taught briefly at San Jose State College
in California. Professor Miller undertook his early academic
training at the University of Michigan, where he received degrees in industrial-mechanical engineering in 1952 and business
in 1954. He Is a recent recipient of a Ph.D. degree from
Stanford University.
18
schedule. Comparatively little steel, under normal
operating conditions, is inventoried by the automotive firm. Anticipated delivery delays, as might be
caused by a steel strike, are countered by shortterm inventory accumulation. It should be emphasized also that these observations refer to large tonnage products, which comprise over 80% of total
steel purchases by the industry. Because steel is
not stocked, automobile manufacturers are heavily
dependent on the steel producer's ability to consistently deliver according to the prearranged schedule.
Any unforeseen interruption in shipments can lead
to an extremely costly production stoppage in the
automotive plant.
Deviations from the planned delivery schedule,
however, become necessary from time to time aa
automobile sales forecasts are revised. Such adjustments normally can be accomplished expeditiously,
because steel mills supplying the automotive industry
usually are located in close proximity to customer
plants, thereby minimizing the amount of steel in
transit at any given time. Similarly, customer production difficulties that are caused periodically by
steel quality variations can be quickly remedied as
they arise.
These market characteristics are approximated in
such other large steel-using industries as major
appliances and containers. In each, prices are negotiated, and the purchaser bargains from a position
of considerable market power. Both the final delivered price and services to be provided by the steel
producer are negotiable, and both can be varied with
prevailing economic conditions and, perhaps, to meet
foreign competition. Tightly maintained delivery
schedules and consistently high product quality are
of major importance.
As an estimate, markets with these approximate
characteristics absorb 40% of the total amount of
steel consumed in the United States. Movements in
list prices in these markets, as reflected in wholesale
price indices, are not necessarily meaningful as an
indication of actual market prices. In periods of
excess capacity in the steel industry, large purchasers can exert powerful pressure on steel producers for additional services and rebates, neither
of which is reflected in publishing price schedules
or by other methods of estimating delivered price.*
Moreover, periods of slack demand in the mass steelbuying industries, because of the relative importance
of such industries in total steel demand, tend to be
correlated with recessions in the steel industry itself.
Comparatively high fixed costs characterize many
purchasing firms and provide an especially strong
motivation to reduce variable expenses, including
outlays for materials, when plants are underutilized.
On this point, see also Lawrence B. Krause, "Import
Discipline: The Case of the United States Steel Industry," Journal of Industrial Economics, Vol. XI
(November, 1962), pp. 33-47.
Journal of Marketing, April, 1968
Large buyers, therefore, have both the incentive and
the bargaining strength to force price adjustments
during recessions or, possibly, in response to import
competition.
Even if a moderate difference in actual prices
favoring imports were to exist, mass purchasers,
as exemplified by auto and appliance manufacturers,
would be reluctant to transfer any significant portion of their purchases overseas. Day-to-day continuity of supply is of such paramount importance
that price differences typically existing between imports and domestic steel producers simply would not
compensate purchasing firms for the additional risks
inherent in foreign supply. This factor could be
reinforced by the opinion of many manufacturing
executives in this country that the availability of
low-priced foreign steel supplies is. at best, a cyclical
phenomenon and, at worst, a manifestation of efforts
by foreign cartels to injure domestic steel firms.
This is not to say that very large users of steel
would not purchase some imported steel from time
to time, especially as a bargaining device in price
negotiations with normal steel sources or when domestic supplies are constrained. But for the bulk
of their requirements, imports would not have served
as an adequate substitute and, as a matter of historical record, have not been utilized to a significant
extent. For example, imports of cold rolled sheet,
an important item in such industries, have grown
in recent years but still account for less than 7%
of total consumption.5
Other markets in which steel is typically millordered are more difficult to categorize. Electrical
and industrial machinery manufacturing firms exhibit purchasing characteristics which are very similar to the mass production industries described
above. For these firms, which account for about
10%-20% of total steel shipments, imports have
been purchased infrequently. For example, the industrial machinery sector is one of the larger users
of hot rolled steel bars. In 1966, less than 6% of
total consumption of this product was supplied by
imports.«
Construction Industry
The construction industry, however, presents a
more complex market situation. This industry accounted for 13.2% of steel industry shipments in
1966.^ For sizable construction projects, such as
large fabricated steel buildings or long bridges,
bidding is limited to a few large contracting firms.
Among these firms are the fabrication divisions of
the steel-producing companies themselves. When the
job is awarded to an independent contractor, steel
normally is purchased on a sealed-bid basis by specAmerican Iron and Steel Institute, Annual Statistical
Report, 1966 Edition, New York, 1967.
Same reference as footnote 5.
Same reference as footnote 5, p. 33.
Price Stability, Market Control, and Imports in the Steel
iflcation. As a consequence, importers can compete
more effectively and have been somewhat more successful, especially in coastal cities. Again, however,
domestic steel sources offer the large contractor more
flexibility on delivery schedules, which is not an
unimportant consideration on jobs of comparatively
long duration. On smaller projects, more contractors
can bid and pricing becomes very competitive. When
the steel order on such projects is still sufficiently
large to justify mill-ordering, requiring less-thancarload quantities of steel, the contractor depends
for supply on the steel service center—to be discussed below.
The size of the construction project, however, is
not the only determinant of possible import competitiveness; t3i)e of product also is important. For
example, reinforcing bars, called re-bars, are another
product used extensively in construction work. Rebars are produced not only by the large integrated
firms but also, unlike heavy structural members, by
a variety of smaller companies throughout the
United States. Virtually all re-bar is purchased directly from the mill. The product is technologically
simple, and, because the grades and sizes are few,
comparatively easy to stock. As a result of these
characteristics, re-bar prices are highly competitive.
Domestic steel producers have no special advantage,
such as they have in the mass production industries,
since re-bars tj^ically are purchased by smaller
contractors in a complete lot to satisfy a particular
job requirement. Under these circumstances, users
have frequently turned to lower-priced import
sources, with the result that in 1966 imports accounted for 17% of total shipments of re-bars.
Other Distribution
Sales through various distributors and jobbers
provide the outlet for steel not ordered directly from
the mill. The most important of these middlemen
is the steel service center, which for the most part
specializes in warehousing a wide range of steel
products and selling locally in small lot orders. Many
service centers are owned by integrated producing
firms, although not all major companies have chosen
to function at the wholesale distribution level.^ In
general, even the independent service centers rely
for steel supplies on the large integrated firms, including in many cases steel producers operating
competitive distributorships.
Very little imported steel has been distributed
through steel service centers, despite the apparent
long-term existence of substantial price differentials
favoring imports. Only when domestic sources are
closed, as during strike periods, have imports been
purchased by service centers. As domestic supplies
8 For example, U. S. Steel, Jones and Laughlin, and
Inland all operate ^captive" service centers; Bethlehem Steel, however, does not.
Industry
19
have been renewed after the strike, imports once
again have been displaced. The reason for this behavior is, of course, obvious for "captive" centers.
For the independent, however, the explanation, while
necessarily somewhat conjectural, probably has been
related to two factors. First, the service center, must
rely on domestic steel sources during periods of
heavy demand overseas, and it must maintain good
relations with the major flrms to assure itself of
a continuous flow of materials. Furthermore, the
management of a small independent center cannot
risk offending its primary steel vendors, since its
business livelihood depends on margins established
and maintained by the majors. Price cutting by an
independent would be quickly matched by competing
"captive" centers. In short, steel service centers are
highly vulnerable to "disciplinary" action and will
not expose themselves to the possibility of such
action without very strong motivation. As yet, the
necessary stimulus does not seem to have been
provided.
The second, probably less important, reason for
service centers refusing to handle imports is concerned with the various federal, state, and local
"Buy-American" laws. In some states these laws
absolutely prohibit the use of foreign materials in
government-financed construction and manufacturing projects. Where only the federal law applies,
domestic materials must be utilized unless outside
sources are significantly less costly. Because of these
laws, importing service centers would be forced to
maintain separate inventories of imported and domestic steel. In the absence of any important price
competition in their product lines from other service
centers, there is little reason to confront the problem, and, again, few have done so.
Specific steel product lines, however, are also
distributed by a variety of non-specialist wholesalers.
For example, small pipe sizes are carried by plumbing supply houses and electrical distributors; baling
wire by agricultural equipment dealers; nails, wire,
and staples by hardware and building supply houses.
In each of these cases, the particular steel products
carried represent an insignificant part of the distributor's total product offering. Moreover, in wholesale situations of this type, price competition is
severe and distributors are acutely conscious of price
differentials. Where these circumstances have prevailed, imports of steel products have generally
become very important. In some product lines, such
imports now account for half of domestic consumption. As a percentage of total shipments, for example, imports absorbed the following proportions
in 1966: nails and staples 46.5%, barbed wire 31.5%,
woven wire fence 29.5%. In some regions, particularly coastal areas, these percentages were even
higher.^
Same reference as footnote 5.
20
Journal of Marketing, April, 1968
Conclusion
In summary, the market structure of the steel
industry has limited areas susceptible to import
penetration. Large segments of the American steel
market essentially have been closed to importers
for various reasons, except in periods of domestic
shortage. Import expansion has occurred largely in
the few market areas where formal distribution
facilities were available or where such means were
not required, as in some construction materials at
port cities. Because of its effective control over
major distribution channels, the domestic steel industry has been able to pursue a comparatively
independent price policy for most products. In some
cases, negotiations with purchasers might have resulted in somewhat lower actual prices, but available
studies have not shown these reductions to be significant. Importers could have surmounted this distribution barrier, in part, by forming service centers
of their own; in fact, they have not done so. As
a consequence, the price response of the U.S. industry to imports in predictably confined product
markets has been straightforward: where the industry price could be maintained, imports have been
permitted to expand virtually unopposed; where market competition among smaller, less integrated producers has resulted in lower prices, the larger firms
have met the market price, while at the same time
holding constant prices at lower levels of fabrication. Interestingly, this latter behavior has led independent producers to accuse their integrated suppliers of "dumping" steel in final product markets,
while complaining about foreign dumping in controlled lines produced only by the large firms.i*'
On this point, see: U. S. House of Representatives,
Select Committee on Small Business, The Impact
Upon Small Business of Dual Distribution and Related Vertical Integration, Hearings, Subcommittee
#4, 88th Congress, 1st Session, Washington, D.C.
(August-September, 1963), pp. 917-927.
-MARKETING MEMO
A Whole New Market? . . .
. . . As our business system races to fill these luxury wants, I believe our market
is becoming transformed again—into a market of fulfillment wants. These have
little to do with the individual's acquisitiveness, but rather with his psychological
and social needs—his yearning for self-fulfillment, for development of his talents,
for an attractive environment, and for the removal of inequalities and suffering in
the backwaters of our civilization that have been passed over by change.
The customer in our market today is not an unthinking consuming apparatus.
He is concemed with education, with health, with culture, with environmental conditions. He wants cleaner, safer cities more than he wants a larger house or apartment. He wants efficient transportation systems more than he wants a bigger, more
powerful car.
Can business, with its great experience and ability to get things done, respond
to the new desires and hopes of our fellow men in an environment rapidly changing
through its own creative technology? Does business have a future in this market?
—J. Wilson Newman, "Does Business
Have a Future," MSU Business Topics,
Vol. 15 (Autumn, 1967), pp. 17, 18.